Column: What’s on Subbarao’s mind

The market,therefore,is clearly indicating what RBI might do next week in its quarterly policy statement. With inflation,in general,not showing any signs of abating,RBI is particularly worried that food inflation is not coming down as was projected earlier,in spite of a bumper rabi harvest. It may be recalled that even Prime Minister Manmohan Singh had made a statement last month expressing optimism about food prices gradually coming down after the rabi harvest. When this did not happen,Manmohan Singh decided to set up a Centre-state mechanism last week to tackle food prices by improving supply administration. More so,RBI’s internal analysis shows that until last November food items contributed to nearly 100% of the rise in the wholesale price index (WPI). However,in recent times non-food items are contributing close to 50% of the rise in the WPI.

The other big concern for RBI flows from the unusual rise in asset prices over the past six months or so,fuelled largely by excess liquidity in the system. Most central bankers in the world kept easy liquidity conditions during 2009 to fuel a faster recovery. However,the easy liquidity largely ended in driving up existing asset prices,without creating any new productive assets. In India,too,private investment growth was hardly visible in 2009,which was clearly reflected in bank credit growth at single-digits. Consequently,a lot of liquidity in the domestic system,later compounded by a recovery in the foreign capital inflows,may have created new asset bubbles. RBI has studied the real estate prices in several cities recently and found evidence of potential real estate bubbles. The recent auction of a 19th floor duplex flat in Worli for Rs 37 crore was described as madness by the head of a global property consultancy. An RBI internal study shows the makings of a bubble even in other cities like Hyderabad,Bangalore,etc. The real estate prices around smaller state capitals like Jaipur,Lucknow,etc,too,have not come down in the past year,following the global crises.

In retrospect,it might have been a big mistake on the part of banks to have bailed out the big real estate players after the 2008-end market crash. The banks,by giving real estate companies financial succour,ensured that the price of real estate did not normalise enough downward. Needless to say,this decision was largely influenced by the ‘politician-real estate baron’ nexus.

Now it is coming back to haunt all of us. The one big consensus shift after the global financial crises was that monetary policy must sharply address asset prices,such as that of real estate. So this time around,real estate is very much on RBI’s agenda.

The other serious worry for RBI relates to how it will manage the exchange rate in view of the increasing surge of capital flows into India searching for higher returns. India may well enter into another phase of liquidity deluge,as it did between 2005 and 2007. If the OECD economies get stuck in a sub-par growth trap and India resumes its 8.5% GDP growth rate,another tide of global capital will hit our shores. RBI is worried that this could create further surge of liquidity in the system at a time when it is trying to suck out excess money. RBI will also be internally under pressure not to allow the rupee to appreciate beyond what it sees as a fair exchange rate that is beneficial to the overall economy. This remains a subjective call as some sectors make more noise than others when the exchange rate moves sharply.

In this context,RBI had prepared a report,which the government was to share with the US treasury secretary. In this report,the central bank expressed deep concern over the prospect of India appreciating its currency based on its largely market-determined exchange rate policy while China continues to maintain a fixed exchange peg. The Chinese currency is seen as undervalued by at least 40% by various experts. Assuming that the rupee is fairly valued at the current exchange rate,Indian exports are already suffering a big disadvantage vis-à-vis China. This situation will only exacerbate if the rupee appreciates by another 10% to 15% over the next few months on account of heavy capital flows,even as the Chinese currency remains pegged. Among other things,this is a top-of-the-mind issue for RBI.

mk.venu@expressindia.com